(Article from Insurance Law Alert, July/August 2025)
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Holding
The Fifth Circuit ruled that an Intellectual Property Exclusion in a liability policy was ambiguous, and separately, that the insured did not establish that one of its employees was “legally obligated to pay” a third party for purposes of triggering the insurer’s defense obligations. Paloma Res., L.L.C. v. Axis Ins. Co., 2025 U.S. App. LEXIS 16588 (5th Cir. July 7, 2025).
Background
Paloma and one of its employees were sued by Continental Resources, a business competitor. The suit alleged that the Paloma employee colluded with two Continental Resources employees to steal confidential information from Continental Resources. The parties ultimately settled, with Paloma stipulating that the suit involved the unauthorized disclosure of and access to Continental Resource’s confidential information. Additionally, under the settlement, Continental Resources agreed to release the employee from liability and the claims against him were dismissed.
Thereafter, Paloma sought to recover its defense and indemnity expenses from Axis. Axis denied coverage, arguing that an Intellectual Property Exclusion applied. In ensuing litigation, a Texas district court granted summary judgment in favor of Axis on two issues: (1) that the Intellectual Property Exclusion barred coverage; and (2) that Axis had no duty to reimburse Paloma for any expenses the company incurred in defending the employee in the underlying litigation.
The Fifth Circuit reversed in part and affirmed in part.
Decision
Reversing the district court’s ruling as to the Intellectual Property Exclusion, the Fifth Circuit concluded that the provision was ambiguous. It barred coverage for loss arising out of “any actual or alleged infringement of copyright, patent, trademark, trade name, trade dress, or service mark or the misappropriation of ideas or trade secrets, or the unauthorized disclosure of or access to confidential information.”
Paloma argued that use of the term “the” immediately before the phrase “misappropriation of ideas or trade secrets” indicates that the phrase “actual or alleged” modifies only the first list of propriety information. Paloma further claimed that with respect to the list of misconduct that follows the disjunctive term “or,” the actual conduct (not merely alleged conduct) is required for the exclusion to apply. Finding this construction reasonable, the court deemed the exclusion ambiguous. In so ruling, the court also noted that the exclusion would be grammatically incorrect if the phrase “actual or alleged” was intended to precede/modify the phrase “the misappropriation of ideas or trade secrets.”
However, the Fifth Circuit affirmed the grant of summary judgment in favor of Axis with respect to its coverage obligations to Paloma’s employee. The Fifth Circuit reasoned that the employee was not “legally obligated to pay” under the settlement, a prerequisite to coverage under the policy. Paloma put forth two arguments in support of its assertion that the employee was “legally obligated to pay.” First, it argued that as a Delaware limited liability company, Paloma had the power to indemnify its employee and therefore that any expenses incurred by the employee could be considered legally owed to Paloma as an indemnitor. Second, Paloma argued that it incurred vicarious liability for the employee’s actions, which constituted a legal obligation to pay on the part of the employee. The Fifth Circuit rejected both assertions, finding them to be without merit and unsupported by Texas law.
Comments
The decision highlights the general principle that the phrase “legally obligated to pay” in insurance policies typically relates to a legal obligation to pay a third party, based on an underlying settlement or judgment. Where, as here, the alleged insured has no obligation to pay the third party, indemnity coverage is generally unavailable.